Net Present Value referred as NPV is one of the commonly used Numerical Investment Appraisal Technique. Theoretically, NPV is the difference between the sum of the projected discounted cash inflows and outflows attributable to a capital investment.
Before moving forward, you need to have the basic knowledge on Time Value of Money & Discounted Cash Flows. If you don't remember, do not hesitate to refer the below link. Sometimes ego kills :p
Step by Step Approach
Calculate the Net Cash Flow (NCF) for each period through out the project life cycle.
Obtain the relevant Cost of Capital (CoC) for the project.
Tabluate the NCF & Discount Factors (DF) for each period methodically.
Find the Present Values (PV) of Future Cash Flows (NCF) for each respective period.
Find the sum of all PVs and that would be your Net Present Value (NPV).
Assumptions
All cash flows happen at the end of the period - I know in reality it is not like that but that is why i said it's an assumption.
Initial Investment happens immediately/now (T0).
There is zero inflation and taxation unless specified in the question.
All cash flows are known with certainty.
Special Notes
NCF = Total Cash Inflow - Total Cash Outflow
CoC will be given in your question. So don't panic.
DF can be found using the present value table or the formula 1/(1 + R)^n
PV = FV * DF or NCF * DF ; NCFs are the Future Cash Flows recorded under each period.
Decision Making - If the NPV > 0, you can consider the investment opportunity as a viable option.You will understand this better with a question. But why a question?? Because there is no other way :)
Example:
A potential investment on machine that has a life of 4 years is $100 million. If the machine is to generate cash flows as below, find the NPV assuming the CoC is 10% for the project & scarp value of $50 million.
Answer:
Intention here is to bring all the future cash flows (Year 1 to 4) to today's value (Year 0) and find the sum of present values (NPV). Bringing to today's value is called finding the present value of each future value using the formula PV = FV * DF.
Main Format
Workings
Points to remember:
Scrap Value is the investment sales value at the end of the life of the project. This is a cash inflow which happens in the last period.
Always have the main format fixed. Do not ever try to modify it.
Whatever the workings you need to do, do it separately under a section called workings and extract data from working to fill the main format.
DFs can be found using the Present Value Table or equation 1/(1+R)^n
Remember, questions can be given in different ways but your intention should always be to find the Net Cash Flows of each period and bring them to Present Value in oder to find the Net Present Value. So that you can comment on a realistic value of the project in today's term.
You need more questions??? Comment below :)
Purindu B Jayatilake
MSc Eng (Reading), MBA, BSc (Hons) Eng, ACMA (UK), CGMA
#management #accounting #account #accountant #managementaccounting #cima #acca #cimastudents #accastudents #unistudents #study #studyguide #theory #basics #investment #appraisal #investmentappraisal #investors #business #businessworld #commerce #advance #advancedlevel #university #notes #usa #asia #UK #economics #analysis #businessanalysis #project #projects
Comments